Does Good Debt Exist?
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When it comes to debt, financial experts have typically marked both “good” and “bad” scenarios. But in today’s touchy economy, the lines are becoming blurred.
To avoid stacks of unpaid bills, many of us are turning to cash instead of pulling out plastic for purchases. That’s a smart move according to a recent study in the Journal of Experimental Psychology: Applied (American Psychological Association), which found fresh evidence that if you’re looking to curb spending, cold hard cash is the way to go. “The more transparent the payment outflow, the greater the aversion to spending, or higher the pain of paying.”
Sarah Evans, director of communications for Elgin Community College (ECC), has made a concerted effort to stick to cash these days in order to avoid debt. “My husband and I accrued a lot of debt right after college,” says Evans. “We used credit cards to make ends meet, buy our professional wardrobe, even for groceries. It took about two-and-a-half years of dedicating the majority of our financial resources to paying it all off.” Now, Evans and her husband pay cash or debit for major purchases. “If we decide to open a credit card to save money on a purchase, we pay it off the next month.”
Get Smart: Examining the Varying Degrees of “Good” Debt
There are some purchases that have long been deemed worth going into debt for – education, for instance. “Education is the one investment no one can ever take away from you,” says Evans. “It is not market-dependent, nor will it ever decrease in value. I am confident in my conscious choice to go into good debt for higher education.” Amy Perrin, director of student financial assistance at ECC, echoes Evans’ sentiment. When she advises students and parents about the cost of college, she asks they consider the benefits of having a degree.
Education is like any other venture, says Perrin, and you should compare the upfront financial obligation to the rate of return on your investment. “My experience has been that the rate of return far outweighs the risk,” she says. “I advise students to apply for financial aid early, research scholarship opportunities, and borrow only what they need to cover costs.” Coming from a community college environment with low tuition costs, Perrin feels confident telling students higher education is a profitable and wise opportunity.
But is it also wise to go deep into dept for a pricey education – believing that borrowing for your degree is a smart choice regardless of the cost? It’s not so simple, says Robert Pagliarini, president of Pacifica Wealth Advisors, Inc. and author of the bestselling The Six-Day Financial Makeover. “Experts have said education debt is always good debt, but I completely disagree.” According to Pagliarini, it’s like saying food – any kind of food – is good. We all know that’s not true. It’s got to be the right kind of food. He feels going into debt to get a degree or to increase your skills is smart if it will translate into a better job and more money. “Do not borrow $50,000 just to get a degree that you’ll never use or that won’t move you forward. You’ll have a nice diploma, but you’ll also be plagued with debt for a long time.”
Even knowing her education-related debt was a necessity, Evans still intensely worried about her credit score when she and her husband purchased their house two years ago. “The night before we got our scores reminded me, ironically, of the anxiety the night before a college exam. Luckily, we didn’t have much to be concerned about. In my case, the credit score worry was situational (the purchase of a home). While it is not on my mind daily, my husband and I do our best to practice good financial habits.”
So What, If Anything, Is “Good Debt”?
According to Manisha Thakor, co-author of On My Own Two Feet: A Modern Girl’s Guide to Personal Finance, it’s worth going into debt for a house you can afford. For most people, this means buying a property that is roughly three to three-and-a-half times their annual household income.
Another debt-green light: A car to get you to work. If you must have one, says Thakor, the purchase price should ideally be no more than 30 percent of your annual income. Additionally, try to put 20 percent down on a loan that is no longer than five years.
Bottom line: The best kind of debt is debt you can afford. This means debt that has monthly payments sufficiently low enough that you can pay it down while meeting all your other necessary living obligations (and a few fun ones, too) with cash.
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24 Comments so far
leave a commentno such thing as good debt. Even all those who will say below me: “A House is good debt”. Mortgage companies exist to make money.
I think there is good debt, just not the regular debt like car payment and house.
But if you are a real estate investor or something like that I think you can build your wealth off of this type of good debt.
By that I mean a debt that brings you in a cash flow stream every month.
What a load of crap! “Another debt-green light: A car to get you to work”
Car=liability not asset it depreciates! Plus it takes $ from your pocket until you sell. Ditto with a house, unless you are making passive income from renting it out or selling it.
The only “good” debt is the kind someone else is paying for (ie passive income through housing)
except when they lose their job and can’t pay you anymore. it still remains your debt even if you don’t have a renter. i’d argue that even the debt you describe is bad debt.
I agree. The quality of debt is a function of risk. Good debt is one where the terms are favorable to repayment without risk of default or significant impact on quality of life. The level of risk one can afford to take depends on their current assets and potential future earnings and their comfort with that risk.
Other factors like tax deductions on depreciating business assets make a liability like a car more palatable. Concerning debt/risk, I find it’s better to be prepared for the worst and hope for the best.
1. Unfortunately, education DOES decrease in value. Two generations ago, most people would finish high school, but it was rare to finish college. Now so many people go to college, it has effectively diluted the value of your diploma. With more education and specialization (and more grad students), the need to attend graduate school is even higher. This makes the risk/reward of student loans one not worth taking. Go to a state school where you can cash-flow and work your way through, or at worst, drastically minimize your student loan burden. $50k/year for the private school down the street from the $10k/year public school is a waste of money.
2. You do not need a car that is “30 percent of your annual income” to “get you to work.” Putting yourself into a monthly payment on a car for an arbitrary period such as 5 years can devastate your path to financial freedom. It is the biggest obstacle most face in trying to financially save and get ahead. Most people claim they can’t save, build an emergency fund, or give to charity because they lack money, when in reality it is being sucked up each month by debt payments.
3. “The best kind of debt is debt you can afford.” In the context given, this is a dangerous and highly irresponsible statement. We need to start asking “how much?” instead of asking “how much per month?” Buying things or charging a credit card up because you can manage a monthly payment is a way to keep you in the rat race forever, not to mention set you up for easy failure should (when) life happens and a monkey wrench is thrown into your plans.
This article starts out with great interviews and research, then ends with lackadaisical and dangerous advice that isn’t proven out by research. Does good debt exist? Perhaps, but a more in-depth analysis should be done on what are acceptable levels of debt.
It IS a great topic though, and will easily spark dialogue! Keep up the interesting topics.
I think it’s a no-brainer that if you DON’T have a car and you need one to get to work, an affordable car that will get you there but is not flashy is good debt. It allows you to make more money. That’s what I view good debt as. I would also think of finance books that you can’t get at the library for free as good debt. Most things that will increase your earning potential or open up your mind to new revenue streams is good debt.
“…nor will it ever decrease in value…”
Well that’s just not true.
People study all kinds of things that become less valuable over time, like if you went to trade school to study carburetor repair… that study went way down in value once fuel injectors came along.
A house is okay, but 3.5 times your annual income!? That’s awfully steep! Sounds like you’d be in a huge 30 year mortgage and asking for trouble.
Car debt is HORRIBLE debt!! Financing a depreciating asset!? No thanks!! Save up and buy something reasonable (aka used) that you can afford in cash.
School debt isn’t good either. Ask anyone who’s working today if they’re really using their degree. Odds are, they’re not. If they are (I am), then where they got it from probably didn’t matter either. It’s just a piece of paper! Point is, you don’t need to go into huge debt to go to some fancy school. Work hard and hopefully get scholarships, then pay for the rest from money you earned.
Flipping the title question around:
Is not having debt a bad thing?
As you’ve mentioned, with the lines blurring between good & bad debt, why not just aim to have no debt? It just seems counter intuitive to think about debt when your goal is to have wealth; as much as it seems intuitive that wealth is the opposite of debt. And debt is more often associated with being poor.
Will I like your idea. How about zero debt! Everyone should aim at having no debt instead of good debt.
here’s a wacky idea….How about you save up money to buy a car. You don’t have to have a $20,000 car to get you to a $60,000 job.
and how about instead of buy as much house as you can possibly afford, you get a house that is no more than twice your annual income…that way, when (not if, but when) you lose your job, hurt yourself, have to move back close to a dying parent, have kids, etc, you can STILL afford the house.
Stuff doesn’t by happiness. But I will tell you first hand that having no payments but the house and loads of cash in the bank sure as heck buys some peace of mind.
Some of the greatest fortunes in the world have been built with debt, or using another term, leverage. But debt is like nuclear power; it’s so powerful that it should only be used by those who understand it and respect it. Otherwise you’re hanging out on http://debtbeat.com trying to dig yourself out.
are those fortunes the same ones we’re bailing out now? i strongly disagree. if you fully understand and respect debt, you would want to have nothing to do with it.
Here is a question, What if you have a 1.5 mil home fully paid for and you can get a 4.5% 15yr loan for $400,000. Why not take the loan and invest it in a way that will return 8%+ yes some risk but with the way the government is spending I have to think we will see interest rates go to 8% in the next few years!
If you lost your job and had no income, would you rather have:
(a) a $10,000 car
(b) a $10,000 car, a $10,000 debt, and $10,000 cash
Just wonderin’…
One traditional definition of ‘good debt’ is debt with an interest rate that is easy to beat in a reasonably secure investment. For example, it would make more sense for me to put extra money into an investment earning 5% interest than to use it to pay down my 3.5% student loan.
woo: re: “Mortgage companies exist to make money. “: so does Taco Bell, but I’m a customer of theirs anyway. The profitability of the seller is unrelated to the value of the product.
A loan is just like any other product: you are paying for something that is useful to you. Specifically, you are paying a lot of money over time for less money right now.
Yeah, except taco bell doesn’t hunt you down and threaten to rip your throat out if you don’t like their food.
Debt is bad. Good debt is an oxymoron. Anyone who gets into debt when they can easily choose not to is a plain moron.
If you want to be rich, live like the rich. If you want to be poor, live like the poor. Rich people pay cash for cars and such. Poor people can’t pay for their cars, so they take out a loan. Hmm….
Great article and tips. I consider a good debt as something that brings you value or has value like buying a home or investment property or starting a business, antiques items or jewelry. I consider bad debts things like clothing, cars, etc.
No matter what you buy you have to use good judgment and outweigh the cost versus the benefits of buying the item or borrowing money to purchase the item.
There is no such thing as “Good Debt”. It’s a LIE.
The FICO score is an “I love debt” score.. it’s of NO value! Anything you “need” a credit score for usually means you’re going into debt; and if it doesn’t, then you don’t need a FICO score! (As in when renting, you just need paperwork to prove you can pay your rent such as bank statements, W2s, etc..)
There is NO such thing on this planet as good debt. To learn more, or a better explanation of why, just google search Dave Ramsey and listen to/read anything this man says!
It seems the readers are a lot smarter than the writer. Sorry, for the criticism but I couldn’t help myself.
Let me go through this one topic at a time. Everyone here has very good points.
Education:
The value does go down, not up. What you learned 30 years ago is not as valuable as you learn today because everything, technology, science, even economics, is changing. Companies are laying off old employees for new ones with new knowledge and cheaper salaries.
Side note: And not to sound like a conspiracy theorist, but what was taught before the Internet was based on what the government wanted you to believe. The history books and science is now being rewritten. And the Internet is making it harder to lie to people.
In addition, like someone else said, not many people end up in jobs using their degree. This is because employers are looking for people with experience as well as degrees. If you get out of school, the likelihood of you getting a job with no experience is slim. You can do internships to get experience, but most people going to school can’t afford to push coffee for free, while still not learning the skills they needs in the workplace.
My advice, is to go to a cheap school, start in a community college and then a state university. Save money while in high-school for your tuition, and live with your parents while going to college so that you don’t have to pay living expenses. Ask your parents to help you get involved in your state’s programs that help you pay today’s tuition and save money with interest, so that you are ready when you start school. Florida has a program like this http://www.myfloridaprepaid.com/ . There is also the Upromise program that your parents and family members can help you save for college and it doesn’t cost them anything http://www.upromise.com/welcome .
To get experience in your degree so that you are employable when you graduate, don’t do internships. Instead, contact companies that you would like to work for and offer to work for free but only if you get to do the job that you want to learn to do and can put the title on your resume. If they don’t let you do the work you are looking to do, go to another company and keep trying to find one that will let you.
Car:
I will never again buy a car with a loan, or brand new. The first car I had bought this way went up in flames (some engine problem) and we got back from the insurance way less than what we paid. In addition, after all the interest on the loan and the five years, we paid way more than it was worth brand new. After that we bought a used car for $700 that drives way better than our brand new car did, and it has lasted longer. Always buy used and pay all in cash. Never pay more than half of what the brand new version is going for. Try to buy no more than 5 years old, and no more than 60,000 miles. And try to get one that had only one owner. And not to sound discriminative, but the older the last owner was the better. Retirees don’t drive around as much as younger people and they take better care of their cars because they want it to be the last car they buy.
House:
The house you are living in is not an investment. An investment brings you in profits, a return on your money. I would advice that your mortgage should not cost more than a forth of your income. You should also have about 6-12 months of mortgage payments saved before you buy the house (because of the current unemployment I don’t recommend the usual 3-6 months). I say before you buy the house because when you start to live in it, you will see new expenses that you never planned for.
If buying a brand new home, don’t buy from a builder they overprice, instead by from a current home owner who has lived in it, and make sure it has aged five years. This way you can see if the builder made any mistakes in the construction; you usually don’t find out these things until a couple years later, sometimes 4 year later.
If you are buying a house for an investment (to rent it out), don’t pay more than 25-50% of its value. As we have learned, home values and rent does go down. Don’t buy during the time when home prices are rising, buy when home prices are at their lowest. This is good advice for someone buying a home to live in as well. But I will tell you that it is more profitable and less expensive to get into the business of virtual real estate (websites).
Don’t ever get an equity loan, and even more important don’t get one to pay off other debts. The banks will advice you to do this but it is in their best interest not yours. It doesn’t make sense to take an unsecured debt and change it to a secured debt with your home as the collateral. At least with the unsecured debt, it will harder for them to try to take your home away if you can’t pay.
Business:
If you want to start a business, it is better to save for it and grow it slowly, than to get business debt. Because when the business fails, you will still be stuck in business debt, and 9 out of 10 businesses fail. So the chances of this happening are pretty high. Don’t listen to the banks when they talk about leveraging your business with debt. Remember they are only trying to benefit themselves, not you.
Overall:
If we all worked to get our debt to zero and control our spending, prices all around will go down, inflation will improve, and our dollar will be more valuable and everything will balance out in the end for the better of all the people. But the banks, including the Federal Reserve “Bank” (it is not a government department), doesn’t want this to happen because that is where they are making all of their money and profits.
Here is another option if you have lots of student loans already. These are programs that can help you get your loans forgiven.
http://www.ibrinfo.org/
http://www.staffordloan.com/repayment/forgiveness.php
“Good” debt is also low fixed debt that beats inflation (current 30 year fixed for a house).
Good debt is debt that other people pay for.